As part of the continuing saga surrounding the credit and liquidity crisis, the most recent episode now involves the insurers of tax-free municipal bonds.
Today Standard & Poor’s Ratings Services slashed the credit rating of bond insurer ACA Financial Guaranty Corp., and downgraded the outlook to negative for the other bond insurers: Ambac Financial Group Inc., MBIA Inc., and XL Capital Assurance Ltd. S&P downgraded ACA Financial’s rating to triple-C, or junk status, from A.
Bond insurers guarantee payments of interest and principal in the event of default by the issuer. They live off their stellar credit worthiness. If these insurers lose their ratings, it could lead to downgrades on hundreds of billions of dollars of municipal debt securities that they insure. In turn, many municipal bond investors, including municipal bond mutual fund holders, could be hurt. These risks tend to be magnified in small municipalities.
At Cadinha & Co., we have always discouraged the use of tax-free municipal bonds because of the questionable credit issue and the vulnerability to tax law change. Accordingly, our clients’ portfolios are not directly affected by this news. We can never be sure, however, that clients do not own tax-free bonds outside of our management. If this is the case, our overall recommendation would be to move away from all insured issues or municipal bond mutual funds, in favor of U.S. Treasury obligations. The risk has simply escalated for holders of these bonds as well as other collateral backed securities. We urge you to review all fixed income investments that you may have, and if we can help in any way please feel free to call us.